Spring Swoon Sequel No Reason for Economic Growth Scare

President of the Federal Reserve Bank of New York William C. Dudley said the slump in payroll growth makes him wary of declaring that the economy is on solid-enough ground for the central bank to scale back its stimulus. Photographer: Scott Eells/Bloomberg

April 22 (Bloomberg) -- Like a horror movie with multiple
sequels, The Economy: Spring Swoon IV probably won’t be as
surprising or as scary as its predecessors.

Repeating the pattern of the past three years, the U.S. is
cooling off as the weather turns warmer, with job growth
slowing, retail sales falling and manufacturing output dropping
after gross domestic product surged an estimated 3 percent in
the first quarter. What’s different this time? The slowdown
isn’t unexpected: Economists surveyed by Bloomberg have had it
penciled into their forecasts for at least a month.

The deceleration is coming in response to an identifiable
cause -- the biggest federal-budget tightening in more than 60
years -- rather than inchoate fears about a break-up among
countries that use the euro, a Treasury-debt default or a hard
landing for China’s economy. And the U.S. looks better prepared
to withstand it, thanks in part to a rebounding housing market.

“There definitely has been a slowdown in the past month,”
said Russ Koesterich, global chief investment strategist at New
York-based BlackRock Inc., the world’s largest money manager
with $3.8 trillion in assets. “I don’t think it is going to be
as dramatic or necessarily as frightening as some of the ones we
had back in ’10, ’11, and ’12, which were really exacerbated by
a lot of geopolitical issues.”

That’s good news for the stock market. While shares may
fall in response to weaker data, a sell-off “would represent a
potentially attractive buying opportunity,” said Jerry Webman,
chief economist at New York-based OppenheimerFunds Inc., which
has $208 billion in assets under management.

‘Mild Correction’

Koesterich agrees. He sees stocks suffering a “mild
correction” of 5 percent to 10 percent during the next few
months before resuming their advance.

“The market can end the year higher than it is today, but
we’re probably going to see some lower prices first,” with the
Standard & Poor’s 500 Index over 1,600 by the close of 2013, he
said. The stock gauge was 1,555.25 on April 19, down 2.1 percent
for the week but up 9 percent this year.

News from the Labor Department on April 5 kicked off the
market chatter about a swoon. Employers in March added the
fewest workers in nine months, increasing payrolls by just
88,000. That was followed by an April 12 Commerce Department
release showing that retail sales dropped last month by the most
since June and a Federal Reserve report on April 16 that factory
output fell 0.1 percent in March.

Solid Ground

William C. Dudley, president of the Federal Reserve Bank of
New York, said the slump in payroll growth makes him wary of
declaring that the economy is on solid-enough ground for the
central bank to scale back its stimulus.

“I’d note that we saw similar slowdowns in job creation in
2011 and 2012,” he told the Staten Island Chamber of Commerce
on April 16. “This, along with the large amount of fiscal
restraint hitting the economy now, makes me more cautious.”

The Federal Open Market Committee in March reiterated its
plan to purchase $85 billion in bonds every month and keep
buying securities until the outlook for the U.S. labor market
improves “substantially.” It also pledged to keep interest
rates near zero as long as unemployment is above 6.5 percent and
inflation isn’t forecast to exceed 2.5 percent.

The unemployment rate was 7.6 percent in March, and the
Fed’s preferred price measure -- the personal consumption
expenditures price index -- rose 1.3 percent in February from a
year ago.

Economic Drag

The drag on the economy from tax increases and spending
cuts will amount to 1.5 percent of gross domestic product this
year, the most since 1950, when military outlays were reduced
after World War II, said Mark Zandi, chief economist at Moody’s
Analytics Inc. in West Chester, Pennsylvania.

That estimate includes the effect of $85 billion in
automatic across-the-board government budget cuts, known as
sequestration, that began on March 1. The Congressional Budget
Office has estimated those reductions alone will reduce GDP this
year by 0.6 percentage point.

Zandi sees growth easing to an annual pace of 1.5 percent
in the second quarter from 3.4 percent in the first before
picking up to 3 percent in the final three months of 2013.

“It felt scarier a year ago, two years ago,” he said.
“The threats we were facing felt more existential and were
impossible to handicap,” he added, referring to such risks as
Greece abandoning the euro and a U.S. debt default.

Diminishing Dangers

Those dangers have diminished following action by policy
makers in Europe and the U.S., the International Monetary Fund
said in its World Economic Outlook released April 16.

The issue facing investors now is a “bit more mundane,”
Koesterich said: How much will growth decelerate in response to
the fiscal drag? That question is “manageable and more
understandable,” he said.

Economists surveyed by Bloomberg have been forecasting for
months that the economy would take a hit from budget belt-tightening. Initially, they foresaw the impact in the first
quarter, after payroll taxes were increased by 2 percentage
points at the start of the year.

Now, they see the slackening occurring this quarter, after
marking up their growth estimates for the first three months of
2013. GDP will climb at an annualized rate of 1.5 percent from
April through June, compared with 3 percent in the first
quarter, according to the median forecast in a Bloomberg survey
of 69 economists from April 5 to April 9. Growth in the second
half of 2013 will average 2.4 percent.

No Shock

The federal budget tightening “isn’t a shock,” said Gus
Faucher, a senior economist for PNC Financial Services Group
Inc. in Pittsburgh. “Businesses are prepared for it and have
taken steps, and government employees know there will be
furloughs.”

The economy also is better placed to weather the fiscal
fallout, according to Roberto Perli, a Washington-based managing
director at International Strategy & Investment Group and a
former Fed economist.

“The starting point right now is a lot stronger than it
was in each of the past three years,” he said. “In particular,
housing is very significant.”

New home construction rose 7 percent in March to a 1.04
million annual rate, the highest level in almost five years,
Commerce Department data showed.

The increased building is unfolding as property values
firm. The median price of an existing house climbed 11.6 percent
to $173,600 in the 12 months ended February, the biggest year-over-year advance since November 2005, according to figures from
the National Association of Realtors.

Gaining Momentum

“Although the pace of the housing-market recovery is
gaining momentum, it is important to keep in mind that we are
still in the early stages of the recovery,” Jeffrey Mezger,
chief executive officer of the Los Angeles-based builder KB Home
said on a March 21 earnings call.

Automakers also look for further gains after a strong start
to the year. Cars and light-duty trucks sold at an average 15.3
million annualized rate in the first quarter, the most since the
same period in 2008, according to data from Ward’s Automotive
Group.

While the increase in the payroll tax and cuts in
government spending are a concern, “everything else seems to be
pretty positive,” Kurt McNeil, vice president of U.S. sales and
service at Detroit-based General Motors Co., said on an April 2
conference call. McNeil said gains in employment and housing, a
thawing in consumer credit and the increase in stock prices
outweighed the negatives.

Lower Costs

Lower energy costs are another plus, thanks to stepped-up
U.S. production of natural gas and oil. Consumers spent 2.7
percent of their household income on home-energy bills last
year, the lowest share in 10 years, according to the U.S. Energy
Information Administration in Washington.

The EIA forecast on April 9 that consumers will pay an
average 6 cents a gallon less for gasoline this summer than a
year ago. Regular-grade gasoline will average $3.63 from April
through September, down from $3.69 a gallon in 2012, the
statistical arm of the Energy Department said.

February could end up being the high point for prices this
year, said Michael Green, a spokesman for motoring group AAA. A
gallon of regular, unleaded gasoline at the pump averaged $3.51
on April 18, down 28 cents from February’s high and 38 cents
from a year ago.

“It’s providing significant savings for families,” Green
said.

Offset Taxes

It’s also helping offset some of the pinch on households
from higher payroll taxes, added Joseph LaVorgna, chief U.S.
economist at Deutsche Bank Securities Inc. in New York.

The Fed also provides support by keeping its asset-buying
program open-ended, so investors don’t keep expecting the
central bank to withdraw stimulus, Faucher said.

“The Fed has learned their lesson” by tying the end of
its purchases to an economic objective rather than to a calendar
date, he said.

“We’re swooning, and it’s largely because of the tax
increases and spending cuts,” Zandi said. As that drag fades
going into next year, growth will accelerate to close to 4
percent and “the economy will have finally emerged from the
long shadow of the Great Recession.”